Are banks now a buying opportunity for investors?‏

28th July 2014

Chris Beauchamp, market commentator at IG Group, comments on the opportunities for investors in the banking sector…

Since the financial crisis, banks have lagged behind the FTSE All-Share index, which has returned 90% in the years following March 2009. By contrast, the five UK banks have returned 83%. One bank, however, has outperformed the index, Barclays. This bank has returned 194% over the same period, accounting for much of the sector’s performance.

As we look towards figures from Barclays, the question is raised as to whether the bank can turn itself around and recover from the ‘dark pools’ crisis and offer a more convincing reason for investment.

Barclays figures are due on 29 July, with adjusted earnings of 23p per share expected on revenue of £26.84bn, both down on the previous year. The last set of quarterly numbers did not bode well for the firm either – profits were down around 5% for the first three months of the year, having been expected to post a small increase. The pressure is now even higher after Royal Bank of Scotland (RBS), supposedly the sick man of the sector, stole the limelight by announcing a bullish update ahead of time.

Banking sector: A buying opportunity?

Even now, however, the picture still looks more promising for Barclays. When compared to RBS, the difference is stark; Barclays trades at 0.7 times tangible book value, versus 0.9 times for RBS, making it cheaper on this compelling metric. Crucially, the current valuation for Barclays seems to point to the idea that the ‘bad bank’ assets are worth little or nothing. RBS managed to sell off assets from its bad bank at a higher than expected price, so the disparity becomes even odder. If the assets are worth more than the market believes, the value contained within Barclays becomes even more compelling.

In addition, the retail business in the UK is still doing well, with as yet no sign of a major impact from the TSB IPO, while the business in Spain has received quiet expressions of interest that may turn into a sale in due course. Profit forecasts suggest a rise of almost 40% this year and 23% in the following year.

Brokers remain optimistic on the shares, with 24 ‘buys’ against 8 ‘holds’ and ‘4 sells’, and a median twelve month target price of 282.5p, an upside of 29.6%.

Even if valuations are pointing in the right direction, there is one major cloud on the horizon. The UK’s competition authority recently unveiled an 18-month investigation into small business accounts and personal current accounts. This is the great unknown – will the investigation recommend wholesale break-up or merely the divestment of branches to encourage competition? Of the two, the latter is the more likely, although it is also possible that no real change will result. It is the uncertainty that will hobble share price performance, with the dark pool element for Barclays paling into insignificance against this.

For Barclays, the two most important developments will be a possible rise in profits, aided by widening margins, and an end to the seemingly endless cash burn – restructuring burns cash, and until the bank finally ends its long reform quest, the need for money is unlikely to decrease.

On a forward PE of 9.5 versus an average of 11.4 for the UK banking sector as a whole Barclays seems more attractive, and while on a yield basis it falls behind HSBC and Standard Chartered, it remains ahead of RBS and Lloyds. The bank has lost a third of its value since the peak on 2013, putting it on the back foot as we head towards results. A strong report, however, could well put Barclays back on track.”